Valuation

Transaction
Consulting

Real Estate
Advisory

Fixed Asset
Management

Introduction to Intangible Assets

Presented by Varun Gupta

®
Agenda

Introduction and Overview of Objectives

Section One: What Are Intangible Assets?

Section Two: Why & How We Value

Intangible Assets?

Section Three: Reconciling the Valuation of

Intangible Assets

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 Introductions

Instructor:

Managing Director, American Appraisal India Pvt. Ltd.

MBA from IIM Calcutta

Over 14 years of Financial Advisory experience

11 years in PwC

2 years in Deloitte

1 year at American Appraisal

Key experience

Business and intangible assets valuation

Financial planning and business modeling

Contact Details

Email: vgupta@american-appraisal.com

Mobile: +91 99 6766 4231

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Course Objectives
The overall objective of this course is to provide you with a working
knowledge of intangible assets, why and how they are valued, and how they
relate to the overall business enterprise

By the end of this course, you should be able to:

Define intangible assets

Describe the major categories of intangible assets

Identify the commonly recognized intangible assets

Define the three most common valuation approaches

Assess which valuation approach(es) best applies to some of the individual intangible
assets

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Section One:
What Are Intangible Assets?
Agenda

Section One: What Are Intangible Assets?

Accounting Balance Sheet v/s Valuation Balance Sheet

Definition and Overview

Types of Intangible Assets

Types of Intangible Assets Defined

Q&A

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Accounting Balance Sheet v/s Valuation Balance Sheet

Book Value and Market Value (as of March 31, 2009)

Book Value Market Value Premium over Book

Company
(INR Bn) (INR Bn) Value

Hindustan Unilever Ltd. 20.6 517.7 2,411%

Infosys Technologies Ltd. 182.5 758.4 315%

ITC Ltd. 137.4 697.7 408%

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* As of March 31,2008
Accounting Balance Sheet v/s Valuation Balance Sheet
Accounting Balance Sheet Valuation Balance Sheet

INTANGIBLE ASSETS

NET WORKING CAPITAL

NET WORKING CAPITAL

FIXED ASSETS
FIXED ASSETS

MARKET VALUE OF
LONG-TERM DEBT

LONG - TERM
DEBT MARKET VALUE
BOOK VALUE OF EQUITY
OF
EQUITY

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Definition and Overview
AS 26(6) of ICAI defines an Intangible Asset as:

“an identifiable non-monetary asset, without physical substance, held for

use in the production or supply of goods or services, for rental to others, or
for administrative purposes.”

IAS 38.8 of International Accounting Standard defines an Intangible Asset

as:

“An identifiable nonmonetary asset without physical substance”

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Types of Intangible Assets

Try to name some of the potential intangible assets a business enterprise

may possess
Potential Assets

Customer Relationships

Contracts

Trademarks / Trade Names

Internally Developed Software

In Process Research and Development

Favorable Vendor Agreements

Non-Compete / Non-Solicitation Agreements

Trained and Assembled Workforce

Applicable Licenses

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Types of Intangible Assets

Intangible assets can be classified into the following categories.

Marketing-related intangible assets

Customer-related intangible assets

Technology-based intangible assets

Contract-based intangible assets

Artistic-related intangible assets

Other intangible assets

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Marketing-Related Assets
Definition

Primarily used in the marketing or promotion of products or services

Types of assets

Trademarks, trade names

Service marks, collective marks, certification marks

Trade dress (unique color, shape, or package design)

Internet domain names

Noncompetition agreements

Most commonly valued assets

Trademarks and trade names

Noncompetition agreements

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Marketing-Related Assets
Trademarks

Any word, name, symbol or device or other devices used in trade to indicate the source of a
product and to distinguish it from the products of others

Legal Protection via

– Patents
– Copyright

Examples
– Reliance “R”
– Nike swoosh
– Coca-Cola script

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Marketing-Related Assets
Trade names

Name under which a particular business is carried on by a company
–Trade name is the name of the company, while the trademark is related to the products or
services sold by that company

Examples
–Britannia, Kingfisher and Nokia names

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Marketing-Related Assets
Internet domain name

Unique alphanumeric name that is used to identify a particular Internet address, such as
american-appraisal.com or icai.org

Noncompetition Agreements

Agreement between buyer and seller of a business that restricts seller from competing in
the same industry for a specific period of time, often within a defined geographic area

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Customer-Related Assets

Definition

Relate to customer structure or customer relationships of the business

Types of assets

Customer lists

Order or production backlog

Customer relationships (contractual and non contractual)

Most commonly valued assets

Customer relationships (contractual and non contractual)

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Customer-Related Assets

Customer Lists

Information about customers such as name and contact information
–May also include other information such as order history and demographic information

Although generally not derived from contractual or other legal rights, they are valuable and
are frequently leased or exchanged.
–Doctor or attorney client lists, magazine subscriber lists

Order or Production Backlog

Source of future earnings from sales that have already been closed but not yet fulfilled

Strong backlog can represent a guarantee of future profits

Customer relationships

A relationship exists between an entity and its customer if:
–the entity has information about the customer and has regular contact with the customer; and
–the customer has the ability to make direct contact with the entity.

Can be contractual or non contractual

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Technology-Based Assets

Definition

Relate to innovations or technological advances and are often protected through
contractual or other legal rights.

Types of assets

Patented and unpatented technology

Computer software

Trade secrets

Most commonly valued assets

Computer software

Patented and unpatented technology

Databases

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Technology-Based Assets
Patented technology

A patent gives the inventor “the right to exclude others from making, using, offering for sale,
or selling” the invention.

Legal protection
–A patent does not protect an idea but rather its embodiment in a product or process
–“Patent Applied For” or “Patent Pending” have no legal effect
–Patent protection ranges from 14 to 20 years
–The standards of what is patentable and their duration differ from country to country

Trade secrets

Information, including a formula, pattern, compilation, program, device, method, technique,
or process, that
–derives actual or potential independent economic value from not being generally known, and
–is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

Legal protection
–Patentable in many cases, but not often elected
–Potential relief in court if someone else improperly acquires or discloses the trade secret

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Technology-Based Assets

Computer software

Two categories
–Product software for sale or license
–Operational software for internal use

Under certain circumstances, computer software may be subject to copyright, patent, or

trade secret protection.

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Contract-Based Assets
Definition

Rights that arise from contractual arrangements

Most commonly valued assets

Licensing and royalty agreements

Lease agreements

Supply contracts

Service contracts

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Other Intangible Assets

In process research & development (“IPR&D”)

An asset is classified as IPR&D if it is a development project that has been initiated and
has achieved material progress, but has not yet resulted in a technologically feasible,
commercially viable product.

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Other Intangible Assets

Goodwill

Value of an enterprise that cannot be associated with any other asset
–Going concern value
–Excess economic income
–Expectation of future events not related to current operations

Assembled workforce

Value in avoiding the costs to locate, hire, and train employees

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Questions?

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Section Two:
Why and How We Value Intangible Assets
Agenda

Section Two: Why and How We Value Intangible Assets

Introduction

Valuation Purposes

Valuation Approaches

Tax Benefit of Amortization

Expected Remaining Life

Q&A

25
Valuation Purposes

Regulatory Compliance
Financial reporting requirements as per the different accounting standards:

Financial Reporting Requirements as per IFRS
–IFRS 3 – Business Combinations
–Revised IAS 36 – Impairment of Assets
–Revised IAS 38 – Intangible Assets

Financial Reporting Requirements as per Indian GAAP

–AS 26 – Intangible Assets

Financial Reporting Requirements as per US GAAP

–SFAS 141 – Business Combinations
–SFAS 142 – Goodwill and Other Intangible Assets
–SFAS 157 – Fair Value Measurements

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Valuation Purposes
Other uses for intangible asset valuation

Transaction assessment

General corporate planning and governance

Financing (collateralization)

Bankruptcy proceedings
–Liquidation value

Litigation support and dispute resolution

Business formation and dissolution

–Contribution of intangible assets by parties

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Valuation Approaches

Based on the present value of

Income Approach expected future cash flows to be
derived from ownership of the
asset

Cost Approach Based on the cost to reproduce

or replace the asset

Based on transactions involving

Market Approach the sale or license of similar
intangible assets in the
marketplace

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Valuation Approaches – Income
Relief From Royalty Method

Based on the cost savings of not having to pay a royalty to a third-party for use of the asset

Common applications
–Trademarks and trade names
–Patents
–Developed technology
–Product software for sale or license

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Valuation Approaches – Income

Multi-Period Excess Earnings Method

Based on present value of prospective net cash flow (or excess earnings) attributable to the
asset

Common applications
–Brands
–Customer Contracts/Relationships
–Backlog
–IPR&D
–Contracts/Licenses
–Developed technology
–Product software for sale or license
–Copyrights

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Valuation Approaches – Income
Other Incremental Income Methods

Based on a comparison of the present value of the prospective revenues or expenses for
the business with and without the asset in place

Common applications
–Noncompetition agreements
–Favorable or unfavorable agreements and contracts

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Valuation Approaches – Cost
Principle of substitution

A buyer would pay no more for an asset than the cost to develop or construct an investment
of equal utility

Cost approach is appropriate when either:

A perfect substitute for the intangible asset can be developed more cost effectively in-
house, or

Stage of development is so early that reliable forecasts of future benefits or markets do not
exist

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Valuation Approaches – Cost
Methodologies

Replacement cost
–Cost (at current prices) to recreate the utility of the asset, using modern materials, production
standards, design, layout and quality of workmanship

Reproduction cost
–Cost (at current prices) to construct an exact replica of the asset, using the same materials,
production standards, design, layout, and quality of workmanship

Common applications

Assembled workforce

Internally developed/Internal use software

Engineering drawings

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Valuation Approaches – Cost

Required inputs

Three components of cost that need to be considered:
–Materials - Costs related to tangible elements of development
–Labor - Costs related to the human-capital elements of development
–Overhead - Management and supervisory, support and administrative, and utility and operating
cost elements of development

Two components of cost that may be considered:

–Intangible asset developer's profit
• Percentage return on developer's investment, or
• Fixed Rupee amount
–Entrepreneurial incentive

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Valuation Approaches – Cost

Obsolescence - reflects that value is not necessarily equal to the sum of

historical costs

Physical deterioration
–Wear and tear resulting from continued use

Functional obsolescence
–Diminished function or utility due to design and construction features

Technological obsolescence
–Innovative changes that allow for lower cost, more efficient, or higher quality production,
resulting in same or superior utility

Economic obsolescence
–Results from external factors such as changes in interest rates, inflation, required rates of
return, and levels of supply and demand

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Valuation Approaches - Market

Premise

Based on guideline transactions involving similar intangible assets and similar market
conditions

Common applications

Least commonly used approach to value intangible assets due to lack of an integrated
market for specific intangibles

Most commonly used to corroborate values from other approaches or establish a range of
values
–Trademarks, trade names, and patents

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Amortization Tax Benefit

Amortization of acquired intangible assets reduces taxable income and

creates an amortization tax benefit

As such, the value of an intangible asset is equal to the present value of:

The asset’s after tax cash flows (excluding amortization of intangible assets); and

The tax benefit resulting from the amortization of the intangible asset for income tax
purposes

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Expected Remaining Life

The period over which an asset is expected to contribute to future cash

flows
Expected Remaining Life depends upon following factors:

The expected use of the asset by the acquirer and target

The expected useful life of another asset or a group of assets to which the useful life of the
intangible asset may relate

Legal, regulatory, or contractual provisions that may limit the useful life or enable renewal
or extension of the asset’s legal or contractual life without substantial cost

Effects of physical deterioration, functional obsolescence, technological obsolescence, and
economic obsolescence

Level of maintenance expenditures required to obtain the expected future cash flows from
the asset

Estimation of the future benefit derived from the trademark and trade name

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Questions?

39
Section Three:
Reconciling the Valuation of Intangible Assets
Agenda

Section Three: Reconciling the value of intangible assets

Introduction

Required Rates of Return

Reconciling Value Indications

Q&A

41
Required Rates of Return

Required rates of return attempt to estimate the return a typical investor

would require

Dependant on perceived risk, liquidity

The weighted average cost of capital or “WACC” is the required return on a

business entity’s invested capital (i.e. equity and debt).

WACC = (% Debt * Kd * (1-Tax Rate)) + (% Equity * Ke)

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Required Rates of Return

The component assets of a business require different returns

Disparate returns reflect differences in perceived risk and liquidity

Intangible assets are often considered the highest risk assets of a business enterprise due
to:
–Lack of versatility
–Illiquidity
–Susceptibility to competitive forces

Goodwill generally has the highest required rate of return

–Usually appears last in the development of a business
–Disappears first in a business demise

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Required Rates of Return

The valuation balance sheet revisited

UnderlyingAssets Invested Capital Value
Required Return=WARA=15.0% Required Return=WACC=15.0%

Normal Working Capital

Required Return 6% Market Value of Interest-
Bearing Debt

Tangible and Other Assets Required Return 8%

Required Return 8%

Intangible Assets Market Value of Equity

Required Returns Required Return 20%

Patented Technology: 18%
Customer Relationships: 22%
Goodwill: 23%

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Required Rates of Return
Established business operations – intangible asset risk factors

Degree of liquidity and versatility

Ability to finance with debt versus equity

Barriers to entry/Degree of competition

Rate of technological innovation in the market

Size of the market

Ability to maintain customer loyalty

Personnel risk (retention of employees with key expertise)

Other risks specific to the intangible asset or its industry

In these instances, the required return can be estimated as a premium to the

WACC or the cost of equity of the company

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Required Rates of Return
Development-stage companies – intangible asset risk factors

Remaining time to market

History of the company bringing products to commercial success

Probability of market and customer acceptance

Viability of technology

Probability of regulatory approval

Anticipated competitor response

Risk of achieving price/performance expectations

In these instances the intangible assets are typically 100 percent equity
financed

Venture capital rates of return can be used to approximate return requirements

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Contact details

Varun Gupta
Managing Director
American Appraisal India

Mobile: +91 99 6766 4231

Office: +91 22 4070 0123
vgupta@american-appraisal.com

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